BOP & exchange rates
Problem 1.
Indicate, how the following events might affect the zloty exchange rate.
a) Polish fruits and vegetables are driven out of the market by cheaper agricultural
product from China. As a result, the Polish exports of fruits & vegetables to Sweden
falls
b) The Standard & Poor has risen the rating of Poland from A- to A+
c) Polish citizens working abroad transfer part of their earnings back to their families in
Poland
d) Due to forecasts of bad weather in July, Polish citizens decide to spent their vacation
in Greece.
Problem 2. (from K&O)
Explain, how each of the following transactions will be recorded in the US BOP.
a) An American buys a share of German stock, paying by placing an order on her
account in Swiss bank.
b) An American buys a share of German stock, paying by placing an order on her
account in US bank.
Problem 3.
Indicate, how the following transactions will be recorded in the Polish BOP.
a) A Polish company sells A goods to a firm B in Vienna for 19 mn PLN. The goods are
transported to Vienna by a Polish company C for 1 mn PLN. Company B doesn’t pay A
immediately, firm A grants B a credit for 90 days. Company B pays C immediately (in
euro).
b) After 90 days, company B pays A, by transferring PLN from its bank account in
Poland.
c) Polish citizen who plans to travel to Greece during the summer buys euro in March
from a Greek bank.
d) A German company buys the shares of a Polish company, paying for the shares in
PLN, which it had bought with euro.
Problem 4. (from K&O)
a) Assume that the current account of a nation of Pecunia displays a deficit equal to – 5
bn USD, and the financial and capital accounts display a surplus equal to + 8 bn USD.
Central bank of Pecunia has bought foreign assets for 2.5 bn USD. Calculate the value
of statistical discrepancy.
b) The nation of Pecunia had a current account deficit of 1 bn USD and a nonreserve
financial and capital account surplus of 500 million USD. Assume that statistical
discrepancy=0.
c) Refer to b). What was the balance of payments of Pecunia in that year. What
happened to the country’s net foreign assets? How did foreign reserves of Pecunia’s
central bank changed? How did this operation affect Pecunia’s money supply?
d) How would your answer to c) change if you learned that foreign central banks had
purchased 600 bn of Pecunian assets in that year?
Problem 5.
Can you think of a reason why a government might be concerned about a large current
account deficit?
Problem 6. (from K&)
A US dollar costs 7.5 Norwegian kroner; the same USD can be purchased for 1.25 Swiss
francs. What is the Norwegian krone/Swiss franc exchange rate?
Answer: The KR/FR exchange rate is 7,5 KR/1,25 FR=6KR/FR.
Problem 7
One dollar is worth 5.3015 pesos, while a euro is worth 7.0089 pesos. What is the euro/USD,
if you know that no arbitrage profits can be made?
Answer: The euro/USD exchange rate should be equal to 0,756 euro/USD.
1. Given the above exchange rate 0,756 euro can be exchanged for 1 USD.
2. 1 USD can be exchanged for 5,3015 pesos.
3. 5,3015 pesos will get 5,3015/7,0089=0,756 euro. No profit can be made.
Problem 8.
Calculate the USD rate of return on the following assets:
a) A painting whose price rises from USD 200 000 to USD 250 000 in a year.
b) A 10 000 pound deposit in a London bank when the interest rate on pounds is 10%
and the exchange rate moves from $1.50 per pound to $1.38 per pound over a year.
Problem 9.
In a given moment in time, in different financial centres around the world the following
exchange rates have been noted:
JPY 12.10/GBP
USD 1.54/GBP
JPY 8.05/USD
a) Write down the no-arbitrage condition.
b) Is there an opportunity for an arbitrage in the example above? Let’s assume that you
have 1USD. What should you do to earn a profit?
Answer:
From the first and second market: JPY 12.10/GPB and USD 1.54/GBP - we can conclude
that the JPY/USD exchange rate is: 12.10/1.54 JPY/USD = JPY 7,857143/USD. Since in the 3rd
market the exchange rate is JPY 8.05/USD, then an arbitrage profit can be made.
For example, you could use dollars to buy yen in the third market (where the dollar is strong) and
sell yen and buy pounds and then sell pounds and buy dollars using the first and second market
(where the yen is strong).
The no arbitrage condition holds that: JPY/GBP * GBP/USD from the first two markets has to be
equal to the JPY/USD in the third market
or
JPY/GBP (1st exchange rate) * GBP/USD*(1/the second exchange rate)*USD/JPY (1/ the third
exchange rate)=1
12,1 JPY/GBP* (1/1,54)GBP/USD *(1/8.05)USD/JPY=/=1 : an arbitrage profit exists!